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If your business accepts credit and debit cards, you’re probably somewhat familiar with credit card processing pricing models. And for those unfamiliar, payment processors may offer several pricing models for credit card processing fees, including interchange-plus, flat-rate, and tiered pricing structures, the latter of which this article explores in depth.
Below goes over the tiered pricing model—what it is, how it works, the benefits, and the pitfalls. By the end of this article, you’ll be able to determine if tiered pricing is the most advantageous pricing model for your business operations. So, let’s find out!
What Is the Tiered Pricing Structure?
Payment processors offer tiered pricing as a pricing model for credit card processing fees. The tiered pricing structure groups interchange fees into three rate tiers. Your processor usually decides which transaction qualifies for which tier. The three tiers are qualified, mid-qualified, and non-qualified.
How Does Tiered Pricing Work?
Any business accepting credit or debit cards has to pay processing fees to the involved entities, including the payment processor and credit card network. Generally, these fees are tacked onto each transaction as a small percentage of the transaction and a fixed amount, such as 2.9 percent + $0.30. The pricing model you choose determines these fees. For example, if your choose flat-rate pricing, every transaction is subject to the same flat-rate fee. For its predictability, flat-rate pricing is a popular model, but it might not be the most cost-effective for your business.
In the case of tiered pricing, your transactions are divvied into one of three tiers, each of which are subject to fees of different rates. Qualified transactions incur the lowest fee, non-qualified the highest. Below outlines the tiered structure to better showcase what kinds of transactions typically fall into each tier.
Tier 1: Qualified transactions
Most payment processors classify qualified transactions as card-present transactions made with debit cards and non-reward credit cards. Because these payment methods are common for brick-and-mortar stores, most customers who shop at physical store locations make qualified transactions. Of the three tiers, qualified transactions incur the lowest processing rates.
Tier 2: Mid-qualified transactions
The mid-qualified rate applies to transactions made with rewards, loyalty, cashback credit cards, as well as keyed-in payments. Transactions not processed within 24 hours of authorization also fall into this category. This tier usually incurs higher rates than the qualified tier, but lower than the non-qualified tier.
Tier 3: Non-qualified transactions
Transactions made with high-risk cards, corporate cards, international cards, as well as those made through a card-not-present (CNP) means, are classified as non-qualified transactions. Additionally, a processor may also categorize a transaction as non-qualified if it’s missing information. Transactions in this tier are subject to the highest rates on their credit card processing fees.
How Much Does Tiered Pricing Cost?
Because each processor determines its tiered pricing structure differently, there is no industry-wide cost associated with tiered processing. Additionally, each processor has the ability to dictate which transaction qualified for which tier. For example, some processors classify cashback credit cards in the non-qualified tier rather than the mid-qualified tier. Because of the variability between processors, this pricing structure is considered more opaque than other structures.
To better understand how impactful these rates are on your business, we’ll explain what interchange fees are and why you’re charged them.
Interchange fees
Credit card networks—Visa, Mastercard, American Express, and Discover—charge a fee for each transaction processed on their network. As stated above, these fees are typically a small percentage of the transaction as well as a fixed amount. However, credit card networks do not charge the merchant directly. Instead, they charge the bank that issued the credit card, which then passes this charge onto the merchant.
Interchange fees are subtracted directly from the transaction funds. This means you receive less in your merchant account than what your customer paid. The interchange fee rate depends on the type of transaction, credit card network, and other factors. The average interchange fees are between 1.15 and 3.25 percent of the transaction plus a small fixed amount.
Note: While Visa and Mastercard operate as networks, American Express and Discover operate as networks and issuers.
Pros and Cons of Tiered Processing Pricing
Pros
- Straightforwardly structured fees
Cons
- Opaque
- Costly
- Inconsistent
What Makes the Tiered Structure Bad for Merchants?
Among merchants, the tiered pricing structure does not tend to be the most popular due to its complexity and the impact of associated merchant account fees. Below details the disadvantages that have led merchants to prefer other pricing structures for their processing fees.
Rate inconsistency
Processors offering a tiered structure pricing model may switch things up from time to time, leaving some merchants surprised when rates for tiers suddenly change. Additionally, processors may change which transaction qualifies for which tier.
Lack of pricing transparency
Its vague nature is one of the biggest disadvantages of this structure. When processors introduce merchants to their tiered pricing structure, they may advertise the qualified tier’s lowest fees without mentioning the other tiers’ higher fees. Additionally, processors may not be transparent in communicating the variety of reasons a transaction may fall into a higher-rate tier.
Very costly
Tiered pricing may seem cost-effective when reviewing the rates for qualified tier transactions. However, the higher rates for mid-qualified and non-qualified transactions often result in the tiered structure being one of the most expensive pricing structures for businesses today, especially due to the fact that eCommerce transactions usually fall into one of the tiers incurring higher rates.
Why Banks Use Tiered Pricing Structures
The primary reason banks use a tiered pricing structure is to pass costs and liabilities associated with transactions onto the merchant. Such liabilities include the possibility of chargebacks and fraud. There is an increased likelihood of these events occurring from transactions typically categorized as non-qualified, such as transactions paid for with corporate or international cards. That said, the higher rate acts as an insurance policy of sorts for these higher-risk transactions.
Alternatives to Tiered Processing
If tier pricing structure doesn’t sound like the most beneficial option for your business, most payment processors typically offer the below pricing structures as alternative options.
Interchange-plus
An interchange-plus pricing structure is composed of two elements: the interchange fee specified by the credit card network and an additional fee (the “plus”) specified by your processor. For example, you may agree with your processor that it will charge you 0.3 percent when someone pays with a Visa card. If Visa’s interchange fee is 1.3 percent, you’ll be charged a total of 1.6 percent.
Interchange-plus vs tiered pricing
Compared to a tiered pricing structure, interchange-plus pricing is far more transparent in that merchants can easily see how much they’re paying their processor. Additionally, the processor’s changing a fixed percent on every transaction results in more consistency, thus more predictability.
Flat-rate
Under a flat-rate pricing structure, a processor charges a flat rate for every transaction. The flat-rate structure is appealing for its simplicity. But the simplicity of a standardized rate comes at a cost. Low-risk transactions that would incur a lower rate under an interchange-plus or tiered pricing model are subject to the same flat rate as high-risk transactions under a flat-rate model. Even still, many merchants still prefer flat-rate to more cost-effective options because it enables easy expense forecasting.
Membership-based
Some processors offer membership- or subscription-based models, in which a processor charges a merchant an annual or monthly fee to process a specific number of card transactions. It’s important to note that this annual or monthly fee is in addition to the interchange fee charged by the network. For this reason, the membership-based pricing model tends to be advantageous for businesses that process a high volume of transactions.
Final Thoughts on Tiered Processing
The tiered pricing structure may be inconsistent, lack transparency, and be more costly than it first seems, though there are particular businesses for which this still might be the best option due to the the types of transactions they process. At PaymentCloud, we’re experienced in helping merchants determine which pricing structure is most beneficial for their business. We also advocate for our clientele to receive the best possible rates under whichever pricing structure they choose for their business. Contact us today to ensure you receive the best possible rates for your business’s credit card processing.
